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Europe’s manufacturers fear landmark carbon import tax may do more harm than good

July 13, 2021, 6:00 AM UTC

When Ursula von der Leyen proposes the world’s most comprehensive climate legislation on Wednesday, one issue will be at the top of the EU Commission President’s agenda: preventing carbon leakage. 

What sounds like an industrial accident in fact refers to the very real risk of manufacturers moving their factories abroad to circumvent costly environmental regulations back home. Not only does this lead to a net increase in global emissions, it also drains a region’s economy of vital jobs and wealth.

Determined to ensure there is a future for Europe’s heavy industry, von der Leyen plans the first-ever tariff imposed on CO2 for goods entering its single market.

The goal is to protect its businesses by leveling the competitive playing field and thus prevent the loss of manufacturing—a sector whose contribution to the EU’s economy has steadily decreased to 14% last year from 20% in 1990.

“The threat from imports is real,” says Cédric de Meeûs, head of public affairs and government relations for Holcim Group. The Franco-Swiss cement producer’s chief lobbyist cited a flood of product coming in from countries like Turkey, Ukraine, and Algeria. 

“They don’t have the carbon costs, so their product lands on the European market at the most competitive price,” he says.  

But while its supporters contend that the legislation will both protect the environment while simultaneously encouraging European businesses to lower emissions, critics say this climate bill is really about limiting global competition and could spark trade wars. Perhaps most worrying for business on the Continent—it might actually hurt the very firms it is designed to aid.

Fit for 55

From the very outset, von der Leyen campaigned for the EU’s top job in July 2019 on the promise of delivering this tax, known as a carbon border adjustment mechanism (CBAM), and appointed one of her top lieutenants to personally oversee the project. 

It constitutes a central pillar of the “Fit for 55” road map to accelerate the EU’s 2030 climate goals—a road map that will also include directives on lowering car emissions and changes to renewable energy legislation, among others.

Due to be presented on Wednesday, the name of the package refers to her total CO2 reduction target by the end of the decade—55%. Under her predecessor, the EU aspired to a cut of just 40% over 1990 levels. 

The question critics ask, however, is whether a CBAM is the most effective tool at decarbonizing Europe’s industry while preserving its ability to compete. In multiple interviews with Fortune, some experts and stakeholders voiced their concerns about its feasibility, legality, and desirability even among the very industries it was designed to protect. 

Not only do some European companies fear the CBAM might be viewed as protectionist and trigger fresh trade retaliations, they also argue it could actually end up harming them. 

“A CBAM will not support European businesses as they make this transformation in a cost-competitive way,” says Felix Seebach, energy and climate policy head at German chemicals group BASF.

While Seebach says the CBAM concept might be attractive to sectors focused on comparatively simple commodities with local supply chains, it would hurt a multinational such as his, which sells thousands of specialized products like polyamide 6—a nylon used in athletic wear. These are processed with the help of inputs at dedicated facilities all around the world, and as such could be subject to a carbon tax levied on the imported raw materials.

“We would prefer a global CO2 price. You wouldn’t even need all 160 countries in the beginning. An agreement on the G20 level would suffice, as you have all the main emitters at the table,” says Seebach. 

Powerless against loopholes

Another issue facing EU leaders and European manufacturers is that there already is a system to protect against carbon leakage in place, and some are loath to see it go while a new system is as yet untested.

Under the EU’s emission trading system (ETS), certain so-called hard to abate sectors receive a limited number of free CO2 allowances that mitigate legislative burdens without running the risk of being viewed as discriminatory by trading partners. These rights were always designed to decrease over time and ultimately expire, but prematurely losing them could have drastic effects, according to companies.

“If [policymakers] handle it badly by aggressively phasing out of free allocation, they could indeed trigger an economic shock that would lead us to change our strategy,” says Holcim’s de Meeûs.

Expectations that a CBAM would likely lack a reimbursement from Brussels for a company’s added CO2 costs when exporting from the EU single market—a kind of subsidy believed to be contrary to World Trade Organization (WTO) rules—also diminishes enthusiasm.  

“Sectors in a CBAM may be protected from imports to a degree, but industries that ship abroad will sustain the full brunt of the transformation costs, because there is no rebate at the border, and that is a real problem for our competitiveness in Europe,” says Seebach. Moreover there is no common accounting methodology for calculating carbon content, which he says could create loopholes in the legislation.

Worse, says Dan Hamilton, director of the Global Europe Program at the Wilson Center, is the fact that either the CBAM or the ETS—or both—could be challenged in the WTO, and European manufacturers could be left with no protection against competition from cheaper, more polluting countries.

“They have been skirting along without a challenge,” he says, referring to the EU’s current free allocation of ETS emission rights. “If someone wants to bring [Europe] before the WTO, this will be one more piece. Whether it would be settled in favor of the EU is hard to say, but I see the makings of quite a major case here.”

Simply replacing one form of carbon leakage protection, the ETS emission exemptions, with another deemed highly vulnerable to legal redress is one reason why industry executives prefer a period where the two overlap.

“A carbon border tax doesn’t exist anywhere in the world,” says Holcim’s de Meeûs. “The worst nightmare would be removing free allowances in favor of a CBAM, which is then challenged internationally, not upheld in court, and we’re left with nothing.” 

EU steel producers, for example, estimate their benchmark supply contracts would cost anywhere from 10% to 20% more compared with non-EU rivals, were they to fully pass on to customers the current ETS spot market price for emission certificates. “Exporters would be done for,” argued one Brussels lobbyist for the industry.

Diplomatic push

In her first comments to the media as the new WTO director-general, Ngozi Okonjo-Iweala said she was in principle open to the idea of a CBAM, but warned it would not be easy to implement one owing to a number of practical concerns. 

“Are there possibilities to look at border adjustment taxes down the line? Yes, we can do that, but we should make sure they are applied, measured, and monitored in a way that is very fair to all members,” she told reporters in February.

Indeed in the latest available WTO meeting minutes from November, Qatar delegates flatly warned that treating products differently based on their carbon content “would seem to go against decades of well-considered jurisprudence.”

Over 20 countries—including emerging markets such as India, Brazil, and Turkey as well as developed countries like Japan, Korea, Taiwan, and Canada—raised concerns after Russia and China insisted the carbon border tax be put forward for debate by the WTO’s Council for Trade in Goods.

EU officials were forced to defend their position on everything from the phase-in period of a CBAM to methods for calculating the levy, as well as discuss other trade instruments better suited to achieve the EU’s goal. 

“My advice is to mount a huge diplomatic push to assuage the concerns of third countries,” says Sam Lowe, trade expert at the Center for European Reform, who expects the EU may end up at least altering its carbon border tax following a likely challenge. 

He worries a CBAM could trigger a new bout of trade disputes at a time when the international rules-based trading system has come under heavy fire, a fear shared by steelmaker ThyssenKrupp

“There’s a risk that it comes back to hurt an export-oriented economy like Germany,” ThyssenKrupp finance chief Klaus Keysberg told reporters in May. “For us the free allocation of carbon credits is much more significant than a carbon border tax, which we only see as complementary to the ETS allowances.” 

According to EU documents obtained by Fortune, the CBAM proposal initially applies only to a few energy-intensive sectors that produce steel, aluminum, cement, and fertilizers. Countries deemed to have some form of carbon pricing can petition to be excluded, and this white list already includes European neighbors such as Norway and Switzerland, home to Holcim.

The Asia-Pacific director of energy security and climate change at the Konrad Adenauer Foundation believes there will be room for countries to negotiate an exemption. China, for instance, started this year a national ETS which already covers more CO2 emissions than its older European counterpart.

“To mitigate fears it might help to identify channels to give the additional income back to the affected countries to implement more climate protection measures,” says the think tank’s Hong Kong–based Christian Hübner.

No silver bullet

While Brussels is in no way looking to pick a fight, it argues it must ensure EU manufacturers are not handicapped because of the bloc’s ambitions to become the first carbon-neutral continent in the world. 

“We do not want to enter into a trade war on climate,” says Pascal Canfin, chair of the European Parliament’s environment committee, reaffirming the CBAM will be WTO-compatible. 

“Our partners have to understand that we cannot ask our companies to pay up to €80 [about $95] for a tonne of carbon while competing with imports that pay none. The best reply for our partners to CBAM would be to put a price on carbon themselves,” he adds.

Von der Leyen’s proposal ultimately still has to pass through the usual legislative process that can take easily over a year or more. During this period, the 27 member states and the EU Parliament can still greatly influence the outcome by potentially tightening the draft bill further or watering it down.

Holcim’s de Meeûs expressed hopes that Wednesday’s broader Fit for 55 climate package would enable Europe’s industry to build a business case for investing in new technologies like carbon capture as well as catalyze demand for environmentally friendly products. 

“The overall framework that comes out on July 14th is only the tip of the iceberg,” he says. “We can churn out all the innovation we want, but if no one buys it, it’s not going to work,” he adds, citing Holcim’s CO2-neutral concrete called ECOPact that is still looking for a market. 

BASF for its part teamed up in March with German industrial gases group Linde and Saudi chemicals company SABIC to develop an electrically heated furnace that breaks down fossil fuels into useful feedstocks. 

Since these “cracker” plants are one of the largest CO2 emission sources in petrochemical processing, Seebach suggested the trio could eventually license this technology to help other countries take firm action on climate change. 

Given the BASF manager is no fan of a CBAM, however, it’s safe to say he won’t be encouraging others to emulate Europe when it comes to imposing an emissions tax at the border. 

“There is no silver bullet for addressing carbon leakage. Cost sensitivities, value chains, and technological challenges are so different in European heavy industry segments, there will be no lean CBAM policy that will just work for all,” he concludes.

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